Lou A Shu ⁽ⁿ⁾ in High Management of WOFE

In July 2010, there was a Sino-Japanese joint venture, Art (Changzhou) Co., Ltd, which was located in an industrial development zone in Changzhou, Jiangsu Province. The ring in his office suddenly was blowing and the chairman Li Genbao was answering the telephone; the person on the other end of the line was Lisa, who was the company’s finance manager. Lisa told Li Genbao, the general manager, Miyake, had disappeared. Lisa needed Miyake to review company financial statements of the first half year, but could not reach him either by contacting his mobile phone or fixed telephone of his apartment. The secretary of Miyake did not know his traveling and vacation schedule. Lisa felt upset, and immediately called Li Genbao, reporting the situation. Li Genbao tried to call Miyake, and his mobile phone was switched off. Li realized that could be a serious problem.

According to the practice, if a high level manager in a WOFE is resigned, removed, or transferred, the company in which the manager is working has to conduct a special auditing. Li Genbao instructed Lisa to entrust an accounting firm to carry out a full audit on Miyake’s performance as a general manager for the period of his tenure.  Two weeks later, the audit report was issued. Li Genbao was totally shocked after reading the report. The audit report identified that Miyake had transferred business opportunities, originally belonging to Art (Changzhou), to the third party company, during a 2-year period in which Miyake had been the general manager of this joint venture company. At the same time, he authorized an unlawful payment of 350,000RMB to one quality authentication agency.

In order to make a full investigation, Li Genbao sent a notice to all company staff, asking them to report the malpractices of Miyake. An export sales man named Zhou reflected a circumstance: Miyake had authorized transfer of transaction opportunity to another company in Changzhou. These export orders originally belonged to Art (Changzhou), Miyake abused his authority, resulting in economic damage, however he personally benefited from the transferring.

Based on the aforementioned fact, chairman of Board of Director Li Genbao reported to economic crime investigation department of Changzhou Public Security Bureau, and requested it to register the case as embezzlement, so that Miyake should take criminal liability. To Li Genbao’s disappointment, Public Security Bureau decided it was not a criminal case; instead, they thought it was a civil dispute, and suggested the company bring action against Miyake in the civil court.

Establishment of JV in Changzhou

In Changzhou, there are many garment production companies. They are producing various kinds of clothing and exporting them to USA, Europe and Japan. In the year of 2000, Li Genbao set up a private factory Art (Changzhou) to manufacture clothing, jointly with other two shareholders. The factory mainly produced high-level garments, and exported them to Japan. Li Genbao led the sales and marketing team, took part in Guangzhou and Shanghai fairs. After a period of hard working, the factory received quite a lot of orders from Japan. The Japanese clients had usually very high requirement on clothing styles and quality; while products of Art (Changzhou) were excellent, with fashionable design. The number of Japanese customers had been increasing year by year. After five years of hard work, sales revenue of Art (Changzhou) reached almost RMB 10 million. Sales leaps and bounds. However the company’s growth encountered a bottleneck, it does not have enough capital to expand productivity and enlarge reproduction.

In China, financing for small- and medium-sized private companies is difficult. This is a widespread phenomenon. The four big state-owned banks and other big commercial banks lean to provide loans to the state-owned enterprises and listed companies; it is so hard for small- and medium-sized private firms to get loans, which greatly hinders the development of those companies. Art (Changzhou) was facing the similar situation after its startup period. Li Genbao and the other two shareholders gathered and discussed to see whether allotment of shares to the Japanese company can solve the issue, and whether to establish a Sino-Japanese joint venture is possible, hoping to find which method can utmostly get the problem fixed. On the other hand, the JV can enjoy preferential taxation policy from the local government. Three shareholders reached an agreement to actively look for a Japanese partner. In the year of 2006, through recommendation of some Japanese customer, Art (Changzhou) identified one potential Japanese investor who thought of being a shareholder of future JV company. Subsequently, the two sides went into the JV partnership negotiation, which took more than one year period.

In the negotiations between Chinese and Japanese, the two sides had met a couple of disputes over some significant issues. First, the Japanese investor hopes to be the majority shareholder once it decided to be allowed to get the shares. It planned to occupy 51% of the equity in the future Joint Venture company. But the Chinese shareholder, especially Li Genbao could not accept the condition. As the company’s founder and biggest shareholder and actual controller, Li Genbao intended to sacrifice part of company’s equity to raise share capital so as to develop the company for the long run. Establishment of JV and transfer of share was not an objective but only a method. Second, if the two parties had dispute, whether to solve these disputes in China or Japan based on Chinese or Japanese laws remains a problem. Because Chinese law has explicit mandatory provisions on Sino-foreign joint venture, it says that all JV enterprises in China should apply to the laws of China and any disputes concerning JV company should be under jurisdiction of Chinese courts.

Finally, the two parties have great dispute on daily management of future joint venture company as well. The Japanese investor made it clear to control actual management the joint venture covering daily operation, finance, personnel arrangement, otherwise they would never become a shareholder. It let Li Genbao feel extremely headache. After consecutive bargaining, both sides made concessions. Li Genbao would be the chairman of Board of Directors, which should consist of six members with three people from China and three from Japan, Li Genbao also acted as legal representative of the joint venture company. The general manager would be nominated by Japanese investor, who was responsible for actual daily management of the company. Because Japanese investor insisted on delegating general manager from their side, and would not make any compromise, Li Genbao thought, there would be of no problem if Chinese shareholders did not participate in the daily management of the company, while he remained as chairman of the board, and also legal representative of the company, he could control the company from macroscopic level rather than daily small issue. What is reasonable argument against the proposal from Japanese side?

At the end, the two sides reached an agreement and signed the contract. In March 2008 the two parties signed the contract of joint venture company. The company was set up in an industrial development zone of Changzhou city. Former staff of Art factory were all transferred to new joint venture company: Arts (changzhou) Co., LTD.

Nominate Japanese general manager

The Japanese guy, Miyake, was 43 years old. He traveled to Fudan University to learn Chinese language when he was young. After 3 years in Fudan University, he was able to speak mandarin fluently, and joined in a Japanese bank, Sakura bank Shanghai branch. The bank was one of the top 10 banks in the world during 90’s last century.

Due to his excellent Chinese, Miyake worked and lived in Shanghai comfortably. He met his current wife in Shanghai, who was born in Nanhui district of Shanghai. But suddenly the Asia financial crisis broke out in 1997, the whole banking system collapsed over the night. A lot of big banks closed, including some large European and US banks. Japanese banks, with the support from central government, were rarely bankrupt; the government led mergers and acquisitions within the industry. In the process of restructuring, the banks carried out massive lay-offs, cost saving campaign, so as to survive in the crisis. Miyake had no professional skill and knowledge and was unfortunately dismissed. He was granted economic damages and returned to Japan.

In the seven years from 1998 to 2005, domestic economy in Japan was very bad. Because Miyake studied Chinese only and had no professional skill, it was extremely difficult for him to get a proper job. He tried thousands of times to apply for a decent job, but failed. While Miyake continued to look for opportunities to send his resume to the potential employers, one day, he found a recruitment advertisement in local newspaper, saying there was a JV company in Changzhou, China, which needed a general manager to take care of all daily business. Employer required candidate to have working experience in China and especially Chinese language capability. Miyake sent the resume applying for the post. In Japan, high level talents were reluctant to work abroad, if they could get a job in home town. Changzhou of China was regarded as remote areas, few candidates apply. Finally employer had five applicants and Miyake is one of them. Now this time good luck visited him. As he could speak Chinese very well, Japanese employers decided to give him the offer to be the general manager of the joint venture company in Changzhou.

Embezzle company’s asset to be personally better off

Miyake had no management experience. He became the general manager of joint venture company only because he was Japanese. He totally understood this point. But his mental state was so dark that he was all day on the alert towards his subordinates. He set a regulation in the company, requiring all the letters and couriers be inspected by him, and all visiting clients must be received by him personally or together with other staff. He secretly instructed IT supervisor that all emails going out and in through company server must automatically had a copy to his mailbox in order to monitor employee’s business. Miyake was also keen on tiny administration issues, for instance, office staff seating arrangement, inspection of office furniture, toilet cleaning etc. As time passed, the employees teased him as “senior receptionist” under the table.

After being the general manager, Miyake met an owner of one private company of Changzhou, He Quanmo, who actively approached Miyake, hoping to be his friend. One reason was that Art (Changzhou) had a great number of Japanese customers and export orders. He Quanmo met Miyake frequently, trying to do business with Miyake. After several dinners, He Quanmo proposed to Miyake that Miyake could utilize his power as general manager to make some money. Miyake agreed. He then appointed his staff to transfer export orders to He Quanmo, who would later pay him 10% of commission based on contract value. Miyake thought that the company’s daily management was in his control. Meanwhile, the Japanese directors trusted him and Chinese directors seldom intervene on daily management. So the deal between the two men was done. From 2008 to 2010 period, Miyake had transferred export orders with the total value of USD1.54 millions, with profits of USD400 thousands. Miyake had received USD150 thousands as commission from He Quanmo.

In June 2010, Miyake got known from Japanese shareholder, that the company would arrange special audit on JV executives. In July 2010, Miyake disappeared.

Fiduciary duty of high level management

Directors, general managers, managers and other senior management personnel are entrusted by the company and agent of the company as well. They are actually controlling and disposing of company’s property and personnel. These senior executives owe duty to the company, and have faithful diligent obligation with utmost goodwill, to the interests of the company, at no expense of company benefit.

Company Act has been amended in 2005, which contemplates a principle of fiduciary duty of corporate executives. Section 148 of Company Act indicates, directors and managers should obey laws and regulations and company constitution, owe fiduciary duty and duty of care to the company. Section 149 defines that eight types of activity are prohibited for those executives, and liability arisen if not followed. For example item 5 regulates, “directors, general manager, high level managers should not use his/her post to make business chance for him/herself or other people, make profit for him/herself or for other people from similar business, without the agreement from general meeting of shareholders, 

Therefore Miyake used his post as general manager, to transfer the business opportunities to other company, which belonged to Art (Changzhou) originally, had violated fiduciary duty and duty of care. He also made money from the transactions, the other company was better off from the transactions. However the company he was serving suffered the loss. In order to avoid such circumstance, the general meeting and the board of directors and the board of supervision must take action and inspect those executives on daily business, to avoid heavy loss of the company.

(The author William Wang is a lawyer of Shanghai Hunglong Law Office, if you wish to communicate with the author about his article, you can email: wwd55@hotmail.com)

Note: Lou A Shu means thief in the Chinese traditional drama.