Board Members Face New Legal Risks in China...and Cultural Challenges in India
from
July/August 2006
by Charlie Deitch
Eyeing a board seat in China, at a Chinese company or at a joint venture with a Chinese corporate partner? Be careful. The risks faced by directors are notably bigger than in the U.S., because China doesn’t have a business-judgment rule to protect you against honest mistakes.
“Directors bear liability not only for any board resolutions that violate the law [including patent infringements] but also for ones that result in a company loss,” warns Owen D. Nee Jr., of counsel at Orrick Herrington & Sutcliffe in New York City. Nee has been wrestling with legal challenges in China since the mid-1970s, when the Bamboo Curtain first began to part and he moved to Hong Kong on behalf of Coudert Brothers, a New York City law firm. The groundbreaking deals he worked on included a 1981 joint venture between China and Arco Oil to build a pipeline to Hong Kong.
For most of the past 30 years, China adopted a virtual hands-off policy toward corporate governance, particularly as it affected joint ventures. But that ended in January after a number of Enron-style scandals and big shareholder losses brought sweeping legal changes. Shareholders now have the right to sue directors if a company loses money.
But as Nee points out, an American board member of a joint-venture company may well be powerless to prevent bad business decisions if the Chinese partner controls most of the board seats, which isn’t unusual. If things do go wrong, Chinese shareholders will now be able to sue the whole board, and a Chinese court could find the foreign director liable, even if it was an honest mistake. That’s probably most likely if the foreign partner controls the company and has more than half the board seats.
As of mid-May, no such suits against American directors had been filed, Nee says, but he thinks this could change, particularly in the banking industry. Many U.S. and other foreign banks have recently bought into local institutions and obtained board seats as part of the deal. A director’s best defense against shareholder suits is the same as it is for dissenting board members in the U.S.: Directors must speak up at meetings, make their objections to a particular vote clear, and insist that their position be recorded in the minutes.
American directors are also at risk if a Chinese company—or other non-American outfit—does business with Cuba, Iran, North Korea, or any of the 30 or so countries subject to U.S. trade sanctions. “No exceptions are granted, even though [trading] is legal where the company is incorporated,” Nee points out. Again, directors of banks may be at growing risk, since some Chinese institutions lend money to North Korea.
A third, somewhat different problem is cultural, says Carson Wen, Hong Kong-based partner in Jones Day’s mergers-and-acquisitions, private equity, and capital-markets practices. “U.S. companies and directors need to go into business with China with an open mind and an open heart and work together with these very smart, very dedicated people who just may not be versed, and understandably so, in the way business is done in the U.S.,” he says. “You have to go in with a certain level of cultural sensitivity, because things are done differently there. Not right, not wrong, just different. For example, in China you never get no for an answer. So what you have to know is, are you getting a real yes—or a yes that is simply a polite no?”
Any company entering China should line up local lawyers, just as any foreign concern should when entering the U.S. Nonresident attorneys are prohibited from litigating cases in China, whether or not they have law degrees earned at Chinese universities. China continues to churn out lawyers at an impressive pace; there are 114,000 of them, up from a mere 200 two decades ago.
American directors of companies or joint ventures in India may find that their greatest challenge isn’t tough corporate law but cultural differences. So says Philadelphia-based Ajay Raju, a Reed Smith partner who heads the firm’s securitization and finance team. Getting deals done is “a process that can get very delicate and long-winded,” according to Raju, because most Indian companies are either big family-owned enterprises or have a large number of family investors and other stakeholders, such as suppliers and customers. Either way, you won’t be negotiating with a company alone, but with a family dynamic. “They’re all sophisticated people—don’t think they’re not—but it’s just like negotiating for a family-owned business in the U.S.,” says Raju. “You have to make sure Uncle Rudy and Uncle John will come to the same table and get on the same page. But in India it happens on a much larger scale.”
As in China, foreign companies doing business in India need to hook up with local law firms. Those most in demand often have attorneys who also trained in the West. “These firms are doing very well for themselves, because one of the traditional problems with Indian law firms has been the inadequate quality of some written work and of their general communication with clients,” says Rohit Chaudhry of Chadbourne & Parke’s Washington, D.C., office, a native of India who has been involved in infrastructure-project financings throughout that country. “The [Indian] lawyers who come out of Western law firms are doing much better at that.”
All aspects of business in India move more slowly than in the U.S.—or in China, for that matter—and this includes the law. “One of the biggest things you have to get used to in India is the pace,” Chaudhry says. “It takes forever for even the simplest of matters, like arbitration and contract disputes, to get resolved.”
Despite that pace, Indian lawyers have a wide range of skills. Raju says he has seen local counsel advise foreign corporations effectively on regulatory issues relating to foreign direct investment and foreign collaborations in India, on processing approvals from the Foreign Investment Promotion Board, on the exchange-control implications of transactions and processing approvals from the Reserve Bank of India, and on matters involving India’s Securities and Exchange Board.
You’ll need patience for sure, in both India and China. But the sheer size of their economies and their rate of growth mean that U.S. companies just have to get involved—and do so with the help of local attorneys.
