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Chapter 8 Fiduciary Duties Introduction: One Controversial Case John v. Robinson (Del 1985) The charter stated that under any circumstance, the shareholders.

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Presentation on theme: "Chapter 8 Fiduciary Duties Introduction: One Controversial Case John v. Robinson (Del 1985) The charter stated that under any circumstance, the shareholders."— Presentation transcript:

1 Chapter 8 Fiduciary Duties Introduction: One Controversial Case John v. Robinson (Del 1985) The charter stated that under any circumstance, the shareholders shall waive the right to hold all directors liable for mismanagement or any wrongdoing. Robinson, one of the directors, was involved in an interest-conflict transaction causing great damages to the shareholders. Q: Could shareholders be entitled to hold Robinson liable?

2 Classification of Corporate Rules Enabling Rules Distributional rules & Structure Rules Supplemental Rules Mandatory Rules: Fiduciary Rules A case recently heard by court in Shanghai Mike is a managing director and CEO of a real estate company. Price of the house in Shanghai was increasing from 2002-2006, then dropped at the 2006 year end.

3 Framework of Fiduciary Duties Theoretical Framework 1930s, A.Berle & G.Means Modern Company and Private Property Separation of Ownership and Management Regulatory Framework duty of care Fiduciary duties duty of loyalty Who shall undertake duties of fiduciary? Directors, officers, controlling shareholders, actual controller

4 General Provision in Chinese Corporate Law Article 148 Directors, supervisors and senior management personnel shall comply with the provisions of laws and administrative regulations and the articles of association of the company and bear fiduciary duties towards the company. Directors, supervisors and senior management personnel shall not abuse their rights to receive bribes or other illegal income and shall not convert company assets.

5 Chinese Regulations of Fiduciary Duties General Regulations Article 148 Detailed Regulations Article 116 Article 117 Article 149 Item 1 (1)~(8) Article 151 Damages Article 149 Item 2 Article 150 Remedies Derivative Suit Article 152 Suit Direct Suit Article 153

6 Section One: Duty of Care Definition and Standards of Care the Business Judgment Rule Overcoming Business Judgment Presumption Remedies for Breaching the Duty of Care

7 The Structure of Duty of Care the board decision making oversights function judicial review the duty of care B J R

8 Standards on Duty of Care Statutory Standards MBCA§8.30 (1997 revised) (directors) ~in good faith ~reasonably believes to be in the best interests of the Co. ~become informed in performing their decision-making and oversight functions with the care a person in like position would reasonably believed appropriate under the circumstances.

9 Standards on Duty of Care Common Law Standards The Delaware Supreme Court has stated a party challenging a business decision must show either the directors failed to act: ~in good faith ~in the honest belief that the action taken was in the best interest of the company ~on an informed basis ALI Principles§4.01 (a) specifying ordinarily prudent person standard. In general, these judicial standards also apply to officers.

10 Facets of Duty of Care Good Faith require directors: (1)honest; (2)not have a conflict of interest; (3)not involved in illegal activity. Reasonable Belief substance of decision-making: furthering Company s interest Reasonable Care procedures of decision-making and oversight: Informed basis, ordinary care, like position, under similar circumstances rarely held liable for mere mismanagement

11 B.J.R (safe harbor) B.J.R rather than a prescription of standards of behavior, but a judicial hands off attitudea golden rule of Company law B.J.R a rebuttable presumption directors performance are honest and well-meaning, decision are informed and rational undertaken. B.J.R not statutorily codified but continues to be developed by the courts, dilute the statutory standards.

12 Operation of B.J.R B.J.R. operates at two levels: (1) It shields directors from personal liability; and (2) it insulates board decisions from review. The burden of rebutting the business judgment presumption rests on the party challenging a directors actions or board decision.

13 Encourages risk-taking nothing ventured, nothing gained Avoids judicial meddling Judges are not business experts, and plaintiffs have incentives that may be odds with the company and body of shareholders. So corporate statutes specify uniformly that corporate management is entrusted to the board. Market Pressure Alternative Mechanism poorly managedstock price falls and hard to raise new capitalvulnerable in proxy fight or takeovermanagers replacedmanager less attractive in the executive job market. Justification for the BJR

14 Reliance Corollary: Delegation of Inquiry and Oversight Functions Reliance Corollary: Directors cannot be expected to learn and know about the full range of the corporations business. Statutes: MBCA§8.42(c)-(e) : directors can rely on information and advice from proper persons. MBCA§8.42(b) under some statutes, it also extends to officers Persons can be relied on: (1) other directors [committees of board] (2) competent officers (3) employees (4) outsider experts [lawyers and accountants]

15 Reliance Corollary: Delegation of Inquiry and Oversight Functions Requirements & Limitations on Reliance Corollary -To claim reliance, directors must have become familiar with the information or advice and have reasonably believe that it merited confidence. -Directors remain subject to general standards of care in judging reliability and competence of source of information (MBCA §8.30). Directors cannot hide their heads in the sand and claim reliance if they have reasonable suspicions that make reliance unwarranted. -Management directors have a correspondingly greater duty to independently verify information.

16 Overcoming B.J. Presumption burden fraud, illegality or a conflict of interest the lack of a rational business purpose gross negligence ~action not in good faith ~decision not reasonably believed to be Companys best interests ~decision not adequately informed ~action from lack of objectivity or independence ~a sustained failure to be informed in oversight function ~receipt improper financial benefit The court Revised MBCA ~charter provision limiting liability ~the statutory safe harbor for conflict interest transactions MBCA§8.31

17 Overcoming B.J. Presumption Not in Good Faith Irrational DecisionWaste Gross Negligence Inattention

18 Not in Good Faith Fraud, Illegality, or Conflict of Interest Fraud Directors knowingly or recklessly misrepresent a material fact on which the board relies to the corporations detriment can be held liable under a tort deceit theory. Conflict of Interests Directors liability and actions validity is dependent on fairness standards that apply to interest-conflicted transactions. Illegality Breach of duty of loyalty

19 Irrational DecisionWaste Rational basis: how much of a business justification is sufficient? Rational purpose test: even board decision that in hindsight seem patently unwise or imprudent are protected from judicial review so long as the business judgment was not- ~improvident beyond explanation…Del ~removed from the realm of reason…ALI.P

20 Gross Negligence Directors must make reasonable efforts to inform themselves in making decisions. Trans Union(Smith v. Van Gorkom)del.1985 A CEO (Van Gorkom) who initiated, negotiated and advocated a merger agreement whose terms may have favored the acquirer (Prizker) Shareholders brought a class action challenging the boards failure to become sufficiently informed.

21 Gross Negligence Trans Union(acquired) Prizker (acquirer) Board of Directors (5 managing directors & 5 outside directors) $ 55 Van Gorkom (CEO) Roman (CFO)

22 Gross Negligence Errors by a board composed of five management directors and five eminently qualified outside directors, according to the court, directors had: -failed to inquire into Van Gorkoms role in setting the mergers terms: -failed to review the merger documents; -not inquired into the fairness of the $55 price, and the value of the companys significant, but unused, investment tax credits; -acted without inquiry the view of the companys CFO (Roman) that the $55 was within a fair range. -not sought an outside opinion from an investment banker on the fairness of the $55 price; and -acted at a two-hour meeting without prior notice and without there being an emergency.

23 Gross Negligence Directors asserted they had been entitled to rely on Gorkoms oral presentation outlining the merger terms, but the court held no reliance was warranted: -Van Gorkom did not explain that he, not Pritzker, suggested the $55 price; -Van Gorkom had not read the merger documents; -Directors did not inquire about senior management, who strongly objected to aspects of the agreement, including the price; -Directors never questioned Romans about the basis for his opinion;

24 Who can be relied on? Shall it be at any circumstance, the director seek outside opinion? Decision Making Process Shall it be at any circumstance, the directors liabilities are the same? Discrimination on the Liabilities of directors Two directors, One specialized in architecture, the other in finance. Allen v. Roydhouse,232 F 1010, P.1015. Other directors are entitled to trust the colleague with the qualification of CPA(UK) Re Cladrose Ltd.(1990) BCLC204, p.208.

25 Inattention Oversight Functions of directors: (1) go beyond decisions making (2) requires directors to inquire into managers competence and loyalty Judicial review has varied depending on whether the director is inattentive to mismanagement, management abuses or illegality.

26 Inattention Inattention to mismanagement: Case: A director whose only attention to the affair of the company consisted of talks with the president [who was a friend] as they met from time to time was sued after the business failed because of the presidents poor business judgment. Learned Hand: (1)The passive director, though he had technically breached his duty of care, could not be liable because nothing indicated he could have prevented the business failure. (2) It would be impossible to know whether the director could have saved the business or how much he could have save.

27 Inattention Inattention to management abuse Court have been less forgiving when a director fails to supervise management defalcations. Directors turned on a blind eye to managers with their hands in corporate till. Liability hinges on whether the director knew or had reason to know of the management abuse.

28 Inattention Inattention to illegality The court held that business judgment rule shields directors who had failed to detect antitrust violations (price-fixing or bid-rigging) by midlevel executives. The MBCA care standards regarding directorial oversight functions also reflects this view: the director may depend upon the presumption of regularity, absent knowledge or notice to the contrary. Official Comment, MBCA §8.30 (b)

29 Remedies for Breaching the Duty of Care 1. Personal Liability of Directors Most Courts: vote for/acquiesced/failed to object MBCA§8.24(d) : Attending shall be assumed to have agreed to the action, unless minutes of the meeting reflect the directors dissent or abstention. Some courts: challenger to show Ds action/inaction 2. Enjoining Flawed Decision enjoin/rescind action/unprotected by the BJR

30 Entrenchment ( ) Self-dealing transaction( ) Executive compensation ( ) Flagrant diversion ( ) Usurping corporate opportunity ( ) Parent-subsidiary dealings ( ) Selling out ( ) Promoters early dealings with the corporation ( ) Duty of Loyalty

31 Chinese Regulations of Fiduciary Duties General Regulations Article 148 Detailed Regulations Article 116 Article 117 Article 149 Item 1 (1)~(8) Article 151 Damages Article 149 Item 2 Article 150 Remedies Derivative Suit Article 152 Suit Direct Suit Article 153

32 Nature of Self-dealing A simple contrasting example: Corporation A is selling a house worth $102,000 B is a business man C is a business man and a director of corporation A Types of transaction Parties to a transaction Purchasing price Market transaction:AB$ 102,000 Self-dealing transaction:AC$ 2,000

33 Nature of Self-dealing Why the purchasing price of the house is only $ 2,000 in a self-dealing transaction? Director C(Seller) a director of corporation A raise the price (Buyer) a business man lower the price Answer : Question: Conflict of Interest Reason

34 Nature of Self-dealing Definition of Self-dealing The conduct of a fiduciary in a transaction that consists of taking advantage of his or her position and acting for his or her own interests rather than for the interests of the corporation. conflict of interest

35 Two broad categories of Self- Interest Nature of Self-dealing Direct Interest Self- Interest Indirect Interest

36 Two broad categories of Self- Interest Nature of Self-dealing e. g. sale & purchase of property loan to & from furnishing of services Direct Interest corporation & director

37 Two broad categories of Self- Interest Nature of Self-dealing Indirect Interest corporation & person or entity (in which director has a personal or financial interest) e. g. with directors close relatives with an entity in which the director has a significant financial interest between companies with interlocking directors

38 Judicial Suspicion of Self-dealing Transactions Two basic assumptions Historical development of fairness test

39 Judicial Suspicion of Self-dealing Transactions Two basic assumptions: Assumption2: group dynamics identify with their interested directors even if they dont have an interest in the transaction Judicial suspicion of procedural fairness Assumption1: human nature advance their own interest rather than the corporations interest Judicial suspicion of substantive fairness

40 Judicial Suspicion of Self-dealing Transactions Historical development of fairness test Late 1800s: rule of voidability regardless of fairness flatly prohibited voidable at the request of the corporation Since early 1900s: Safe harbor test substantive and procedural fairness tests abandon the flat prohibition be valid if properly approved

41 Safe harbor tests in four statutes: Delaware GCL § 144 1984 MBCA § 8.31 1989 MBCA § 8.61 (Subchapter F) ALI Principles of Corporate Governance Statutory safe harbors

42 Statutory safe harbors in four statutes Three basic principals of Safe harbor tests: disinterested directors approval, or disinterested (qualified) shareholders approval, or fairness

43 Analysis of similarities and differences of the four statutes in details Statutory safe harbors Analysis of similarities of the four statutes in details Burden of prove in the litigation Directors or shareholdersBurden of proveContent DisapprovedDefendant (Interested directors)Validity ApprovedPlaintiffInvalidity

44 Statutory safe harbors Objective test: terms of the transactionprincipally the price Corporate value: corporations needs and scope of its business Two aspects of Substantive Fairness Standard

45 Statutory safe harbors Analysis of differences of the four statutes in details Interested persons in a self-dealing transaction: StatutesInterested persons Delaware GCL § 144Directors + Officers 1984 MBCA § 8.31Directors 1989 MBCA § 8.61 (Subchapter F) ALI Principles of Corporate Governance

46 Disclosure in a self-dealing transaction Content of disclosure in a self-dealing transaction: Existence and nature of conflict of interest Material information Disclosure requirements in a self-dealing transaction: StatutesDisclosure requirements Delaware GCL § 144 fully disclosed: at the directors & shareholders approval disclosed or not: when judge determines the fairness 1984 MBCA § 8.31 1989 MBCA § 8.61 (Subchapter F) ALI Principles of Corporate Governance fully disclosed: in any circumstances Statutory safe harbors

47 Quorum requirements in the directors & shareholders approval Quorum requirements in the directors approval StatutesQuorum requirements Delaware GCL § 144Majority (at least one disinterested director) 1984 MBCA § 8.31Majority (at least two disinterested directors) 1989 MBCA § 8.61 (Subchapter F) ALI Principles of Corporate Governance Quorum requirements in the shareholders approval Majority of disinterested or qualified shareholders

48 Statutory safe harbors Judicial review of the directors & shareholders approval Judicial review of the directors approval statutes Judicial review of directors approval Delaware GCL § 144Substance 1984 MBCA § 8.31 1989 MBCA § 8.61 (Subchapter F)Diluted Substance (Rational: care, best interest, and good faith) ALI Principles of Corporate GovernanceDiluted Substance (Reasonable) Judicial review of the shareholders approval Statutes Judicial review of shareholders approval Delaware GCL § 144Substance 1984 MBCA § 8.31 1989 MBCA § 8.61 (Subchapter F)Process ALI Principles of Corporate GovernanceDiluted Substance (waste or gift)

49 General Remedy Exceptions to Rescission Remedies for self-dealing

50 General Remedy Rescission Rescission: Returns the parties to their position before the transaction Exceptions to Rescission Damages Damages: The profit made by the director in the self-dealing transaction

51 Chinese Regulations and Comments

52 Who shall undertake the fiduciary duties Persons directly subject to fiduciary duties directors, supervisor and senior manager Person indirectly subject to fiduciary duties controlling shareholder, actual controlling party

53 General Regulations Article 148 Article 148 The directors, supervisors and senior managers shall comply with laws, administrative regulations and the articles of association. What are senior managers? Are CFO and CTO senior manager? They shall bear the obligations of fidelity and diligence to the company. No director, supervisor or senior manager may take any bribe or other illegal gains by taking the advantage of his authorities, or encroach on the properties of the company.

54 Definition of Senior Managers Article 217 The "senior manager" refers to the manager, vice manager, person in charge of finance of a company, and the secretary of the board of directors of a listed company as well as any other person as stimulated in the articles of association. Article 124 Listed companies shall appoint a board secretary to be responsible for preparation of meetings of the shareholders meeting and board of directors, keeping of documents, management of shareholders information and handling of information disclosure etc.

55 The Qualification of Directors, Supervisors and Senior Managers Q: Who shall be deprived of qualification? 1. A person aged at 17 2. A person sentenced for 5-year in prison for conviction of rape but now released from the jail 3. A person chaired as CEO of a company which was bankrupt in the end 4. A person who acting as a legal representative of a company which business license was revoked for a breach of law 5. A person who has great amount of debts for having purchased a big single house

56 Regulations on the Qualification Article 147 The following persons shall not act as a director, supervisor or senior management personnel: (1) a person who has no civil capacity or who has limited civil capacity; (2) a person who has been convicted for corruption, bribery, conversion of property or disruption of the order of socialist market economy and a five-year period has not lapsed since expiry of the execution period or a person who has been stripped of political rights for being convicted of a crime and a five-year period has not lapsed since expiry of the execution period;

57 Regulations on the Qualification (3) a person who acted as a director, factory manager, manager in a company which has been declared bankrupt or liquidated and who is personally accountable for the bankruptcy or liquidation of the company; and a three-year period has not lapsed since the completion of bankruptcy or liquidation of such company;

58 Regulations on the Qualification (4) a person who has acted as a legal representative of a company which has its business license revoked or being ordered to close down for a breach of law and who is personally accountable, and a three- year period has not lapsed since the revocation of the business license of such company; and

59 Regulations on the Qualification (5) a person who is unable to repay a relatively large amount of personal debts. Where the election or appointment of a director, supervisor or senior management personnel is in violation of the aforesaid provisions, such election or appointment shall be void.

60 General Regulations Article 217 (2) Controlling shareholder shall mean a shareholder who contributes to 50% or more of the capital of a limited liability company or a shareholder who holds 50% or more of the shares of a company limited by shares or a shareholder who is able to exercise significant influence on the resolutions of the shareholders meeting or a shareholders general meeting even though it contributes to less than 50% of the capital or holds less than 50% of the shares. (3) Actual controlling party shall mean a party which exercises actual control over a company as investor or through other agreements or arrangements even though it is not a shareholder of the company.

61 Detailed Regulations Article 116. 117 Article 116 No company may, directly or via its subsidiary, lend money to any of its directors, supervisors or senior managers. flatly prohibited policy, why? Shall company lend money to shareholders? Art. 149(3) Article 117 A company shall regularly disclose to its shareholders the information about remunerations obtained by the directors, supervisors and senior managers from the company.

62 Detailed Regulations: Interested Transaction Article 16 (Section 2) In the case of a company providing guarantee for a shareholder or the actual controlling party of the company, a resolution passed by the shareholders meeting or a general meeting is required. Shareholders stipulated in the preceding paragraph or shareholders controlled by the actual controlling party stipulated in the preceding paragraph shall not participate in the resolution in respect of the matter stipulated in the preceding paragraph. Such a resolution shall be passed by a simple majority of votes cast by other shareholders attending the meeting.

63 Detailed Regulations: Interested Transaction Article 125 Where any of the directors has any relationship with the enterprise involved in the matter to be discussed at the meeting of the board of directors, he shall not vote on this resolution, nor may he vote on behalf of any other person. The meeting of the board of directors shall not be held unless more than half of the unrelated directors are present at the meeting. A resolution of the board of directors shall be adopted by more than half of the unrelated directors. If the number of unrelated directors in presence is less than 3 persons, the matter shall be submitted to the shareholders' meeting of the listed company for deliberation.

64 Detailed Regulations: Duty of Loyalty Article 149 Item 1 (1)~(2) Article 149 No director or senior manager may have any of the following acts: (1) Misappropriating funds of the company; (2) Depositing the company's funds into an account in his own name or in any other individual's name;

65 Detailed Regulations : Duty of Loyalty Article 149 Item 1 (3) (3) Without the consent of the shareholders' meeting, shareholders' assembly or board of directors, loaning the company's fund to others or providing any guaranty to any other person by using the company's property as in violation of the articles of association;

66 Detailed Regulations : Duty of Loyalty Article 149 Item 1 (4) (4) Signing a contract or trading with this company by violating the articles of association or without the consent of the shareholders' meeting or shareholders' assembly ;

67 Questions for Analyses & Discussion Question : categories of self-interest: Signing a contract or trading with this company direct interest Disadvantages? (indirect interest)

68 Questions for Analyses & Discussion Question : exemption condition: articles of association or shareholders' meeting or shareholders' assembly The reasons? Advantages & Disadvantages? Why not the board of directors?

69 Cases for Discussion Case : One director was involved in a self-dealing action. He argued that the article of the association prescribed interested transactions would be valid with the approval of the board of director. And he did get such a approval from the board. Questions for Discussion: Shall the director be held liable for the action? Who should bear the burden of proof?

70 Detailed Regulations: : Duty of Loyalty Article 149 Item 1 (5) (5) Without the consent of the shareholders' meeting or shareholders' assembly, seeking business opportunities for himself or any other person by taking advantages of his authorities, or operating for himself or for any other person any like business of the company he works for;

71 Questions for Analyses & Discussion Question : definition of corporate opportunities? interests & expectancy test or line of business test or fairness or intrinsic fairness test or two-step analysis or categorical rule (close corporation) & selective rule (public corporation)

72 Questions for Analyses & Discussion Question : justification for taking a corporate opportunity: consent of the shareholders' meeting or shareholders' assembly any other justifications? corporate refusal corporate inability in good faith and not compete with corporation third party unwillingness ultra vires or other legal incapacity

73 Questions for Analyses & Discussion Question : legal attitude toward competition with the corporation ? prohibited or restricted or allowed

74 Cases Analysis Case : One senior manger of a company was seeking to rent an apartment for the companys employees. With efforts and time consuming, he found an apartment for sale in the East China University of Politics and Law. Then the manager bought this apartment for himself. Questions for Discussion: Is that some kind of usurping the corporate opportunity ?

75 Detailed Regulations : Duty of Loyalty Article 149 Item 1 (6)~(8) (6) Taking commissions on the transactions between others and this company into his own pocket; (7) Disclosing the company's secrets without permission; (8) Other acts that are inconsistent with the obligation of fidelity to the company.

76 Detailed Regulations : Duty of Loyalty Article 151 Article 151 If the shareholder's meeting or shareholders' meeting demands a director, supervisor or senior manager to attend the meeting as a non-voting delegate, he shall do so and shall answer the shareholders' inquiries. The directors and senior managers shall faithfully offer relevant information and materials to the board of supervisors or the supervisor of the limited liability company with no board of supervisors, and none of them may obstruct the board of supervisors or supervisor from exercising its (his) authorities.

77 Remedies Damages Article 149 Item 2 & Article 150 Article 149 Item 2 The income of any director or senior manager from any act in violation of the preceding paragraph shall belong to the company. Article 150 Where any director, supervisor or senior manager violates laws, administrative regulations or the articles of association during the course of performing his duties, if any loss is caused to the company, he shall make compensation.

78 Questions for Analyses & Discussion Question: The relationship between seizure of income & compensation?

79 Executive Compensation Question: Why the executive compensation is also a form of self-dealing transaction? To find out the Answers: Step1: Who will authorize the compensation? Who (Chinese regulation) Who (MBCA & Delaware) Directors Shareholders meeting Closely held corporation: shareholders negotiation Public corporation: committee of outside directors OfficersBoard of directors

80 Step2: What if the director is in control of the shareholders meeting? Executive Compensation the director will decide his own compensation. Self-dealing Transaction What if the officer is also a director? the officer will decide his own compensation. Self-dealing Transaction

81 Forms of Executive Compensation Salaries Bonus Stock plans: Stock grants Stock option Phantom stock Stock appreciation rights Pension plans Direct forms: Fringe benefits: Expense accounts ( Company residents Use of corporate jets Indirect forms :

82 Judicial Review Statistics of compensation judicial review of the compensation

83 Judicial Review Statistics of compensation Contrasting statistics: (Payments in 1993) A pharmaceutical corporation in New Jersey The USA CEOOfficersThe presidentCongressman $1,380,000$600,000- $1,060,000 $200,000$100,000 Remarks: $1,380,000 $200,000 × 6.9

84 Judicial Review Managing a corporation or managing the whole country? Question: Which one is more difficult?

85 Judicial Review

86 Amazing graphs: Judicial Review

87 the Overcompensation of American Executives CEOs are paid hugely in good years if not hugely, then wonderfully in bad years. The most famous critic: Judicial Review

88 Incentive effect (primary) maximization of corporations value Tax motivation avoid double taxation Squeeze out minority shareholders judicial review of the compensation purpose of compensation plans:

89 Judicial Review Business Judgment Review (BJR) Grossly uniformed Waste General regulations of compensation: Substantive Fairness Review the executives qualification, ability, responsibility, time devoted the corporations complexity, revenues, earnings, profits the possibility of fulfillment of the incentive compensation the compensation of similar executives in comparable corporation Without disinterested directors approval With disinterested directors approval

90 rule of SEC Disclosure of executive compensation Disclosure of shareholders suggestion of executive compensation in proxy solicitation Disclosure of the value of stock option of officers Other necessary regulations of compensation: Judicial Review

91 Chinese Regulations and Comments

92 Regulation : Article 117 A company shall regularly disclose to its shareholders the information about remunerations obtained by the directors, supervisors and senior managers from the company. Personal comments : Who enforce the regulation? Chinese Regulations and Comments

93 Article 38 (2) The shareholders' meeting shall determine the matters concerning the director and supervisors remuneration. Regulation : Chinese Regulations and Comments Article 47 (9) the board of directors shall making decisions on the remuneration of company's manager, vice manager(s) and the person in charge of finance Q: any self-dealing in the context of the above provisions?

94 RemediesLitigation Derivative Suit The Nature of Derivative Suit 1. Solution to the dilemma of corporate law 2. Two Suits in One 3. All Recovery to Corporation 4. Reimbursement of Successful Plaintiffs Expenses

95 The Nature of Derivative Suit 1.Equity jurisdictions ingenious solutions to the dilemma created by two inconsistent tenets of corporate law (1) Corporate fiduciaries owe their duties to the corporation (2) The board of directors manages the corporations business, including authorizing lawsuit in the corporates name.

96 The Nature of Derivative Suit 2. Two Suits in One (1)Shareholders sue on behalf of the corporation to enforce rights of the corporation. (2)The corporation, an indispensable party, is made a nominal defendant, which can compel the derivative suit plaintiff to comply with various procedural requirements.

97 The Nature of Derivative Suit 3. All Recovery to Corporation Enforcing the corporate rights: any recovery in derivative litigation generally runs to the company. Shareholder-plaintiff shares in the recovery only indirectly, to the extent her shares increase in value because of the corporate recovery. Some Exceptions

98 The Nature of Derivative Suit Exception: ALI Principles §7.01 (d) When involving a close corporation, a court may exercise its discretion to allow direct shareholder recovery, provided the corporation is not exposed unfairly to multiple claims, creditors are not materially prejudiced, and the recovery can be fairly distributed.

99 The Nature of Derivative Suit 4. Reimbursement of Successful Plaintiffs Expenses Why would a shareholder, particularly a shareholder in a public corporation, undertake the efforts and expenses of a derivative suit? The prevailing American rule: each litigant bears his own expenses. The universal rule in derivate suit: corporation pays the successful plaintiffs litigation expenses, including fees. Theory: the plaintiff (and her attorney) produced benefits to the corporation, and they should be reimbursed for their efforts. Practice: PlaintiffSelf-appointed Representative, should fairly and adequately represent the interests of the shareholders

100 The Rules of Chinese Company Law on Derivative Suit: Article 152 Article 152 Where a director or senior manager is under the circumstance as stated in Article 150 of this Law, the shareholder(s) of the limited liability company or joint stock limited company separately or aggregately holding 1% or more of the total shares of the company for more than 180 days consecutively may require the board of supervisors or the supervisor of the limited liability company with no board of supervisors in writing to file a lawsuit in the people's court.

101 The Rules of Chinese Company Law on Derivative Suit: Article 152 If the supervisor is under the circumstance as stated in Article 150 of this Law, the aforesaid shareholder(s) may require the board of directors or the acting director of the limited liability company with no board of directors to in writing lodge a lawsuit in the people's court.

102 The Rules of Chinese Company Law on Derivative Suit: Article 152 If the board of supervisors, or supervisor of a limited liability company with no board of supervisors, or the board of directors or the acting director refuses to lodge a lawsuit after it (he) receives a written request as mentioned in the preceding paragraph, or if it or he fails to file a lawsuit within 30 days after it receives the request, or if, in an emergency, the failure to lodge a lawsuit immediately will cause unrecoverable damages to the interests of the company, the shareholder(s) as listed in the preceding paragraph may, on their own behalf, directly lodge a lawsuit in the people's court.

103 The Rules of Chinese Company Law on Derivative Suit: Article 152 In the event of an infringement of the legal interests of the company by others which causes the company to suffer damages, shareholders mentioned in (1) above may file a lawsuit with a peoples court in accordance with the provisions of the aforesaid paragraphs.

104 . The Qualification of Plaintiff The following realities invite weak-willed and evil-hearted plaintiff: (1) The plaintiff may be indifferent to the outcome of the litigation. The financial interests in the recovery will be small. (2) The plaintiffs attorney may be indifferent to the substantive outcome The fees are usually contingent on a settlement or court award. (3) The individual defendants usually will prefer settlement rather than trial. The expenses or costs will be indemnified by the corporation or covered by insurance. Strike suit plaintiff: waste and abuse judicial resources.

105 . The Qualification of Plaintiff 1. Contemporaneous ownership requirements Most statutes require the plaintiff to have been a shareholder when the wrong occurred.(MBCA § 7.41(1)) To make sure shareholders did not buy shares to buy a suit. Exception: When an undisclosed wrong (such as a pattern of waste) was continuing when the plaintiff aquired her shares. ALI Principles § 7.02(a)(1) 2.Contiuning Interests requirements Some statutes require that the plaintiff continue to be a shareholder when suit is brought and then through trial.(Cf. MBCA 7.41(1))

106 The Rules of Chinese Company Law on Qualification of Plaintiff qualified plaintiff: · limited liability company shareholder(s) · joint stock limited company separately or aggregately 1% or more of the total shares more than 180 days consecutively Advantages & Disadvantages? No contemporary ownership rule: encourage litigation Shareholding requirement for JSC: Fairness & Standing

107 . The Pre-suit Demand Purpose: to prevent abuse of the judicial process and protect the integrity of centralized corporate governance. Finding a Corporate Voice: Who shall have the right to dismiss such suits: Why not shareholders? (1) Shareholders may lack the incentives to evaluate the relative costs and benefits of derivative litigation. (2) Allowing a shareholders majority to refuse to litigate could entail an expensive and burdensome proxy contest before suit, which would kill derivate litigation.

108 . The Pre-suit Demand The Dilemma of boards power to speak for the corporation: The BJR rule: The directors, more than shareholders or judges, are better positioned to evaluate whether a claim has merits. Interest conflicts: When the claim involves charges of a fiduciary breach, corporate law doubts the boards impartiality.

109 . The Pre-suit Demand Two Balance Schemes 1. Demand-required (futility exception) Demand-Required Board decides fate of claim, subject to review under BJR Demand-Excused Claim goes forward; board can not dismiss 2. Universal-demand (Waiting period)

110 . The Pre-suit Demand Demand-Excused When is demand excused? Various tacks taken by court. Board tainted: Only if the shareholder-plaintiff shows that a majority of the current board is either personally interested in the challenged wrongdoing or dominated by the wrongdoer. Boards objectivity in doubt: Only if the shareholder- plaintiff can allege with particularity facts that the majority of the directors are disinterested and independent.

111 . The Pre-suit Demand Universal Demand (waiting period) A shareholder wishing to file suit must make a demand and then wait 90 days, unless the board rejects the demand or waiting would result in irreparable injury to the corporation. Special litigation committee (SLC) : consists of disinterested and often recently appointed directors, decide whether the litigation should go forward.

112 The Rules of Chinese Company Law on Pre-suit Demand Pre-suit Demand: · directors & senior managers board of supervisors or supervisors · supervisors board of directors or executive directors premises of suit: refusal of suit or failure to suit within 30 days or emergency

113 Questions for Analyses & Discussion The reason of dual system Advantages & Disadvantages? (qualification of supervisors judgment) (litigation committee) Exemptions of Pre-suit Demand? (emergency…) Burden of proof? If the defendant is the third party, to whom shareholder-plaintiff shall make a demand for suit?

114 Questions for Analyses & Discussion Question : qualified defendant: directors senior managers supervisors anyone impair the corporation What is the standing of corporation in this lawsuit? Corporation: plaintiff or defendant?

115 Questions for Analyses & Discussion Other Related Questions: securities for expenses? settlement? monetary and nonmonetary relief? litigation expenses? lodestar formula or percentage-of-the-recovery or combination method D&O indemnification and liability insurance?

116 Cases for Discussion Case : The board of director of Company A made a decision to sell a spare apartment for 100, 000 RMB, while the shareholders thought the price was much lower than expected. Can they bring a suit against the directors? Questions for Discussion: Business Judgment Rule and Damages Rule

117 RemediesLitigation Direct Suit Article 153 Article 153 If any director or senior manager damages the shareholders' interests by violating any law, administrative regulation or the articles of association, the shareholders may lodge a lawsuit in the people's court.

118 How to characterize the Direct Suit Direct suits vindicate shareholders financial, liquidity and voting rights. To compel payment of dividends declared but not distributed To challenge fraud on shareholders in connection with their voting sale, or purchase of securities To require the holding of shareholders meeting To compel inspection of shareholders list or corporate bonds at records.

119 Class Actions: Direct Suits Brought by Representative When a shareholder sues in his own capacity, as well as on behalf of other shareholders similarly situated, the suit is not a derivative suit but a class action. Chinas Practice: the right incentive of Judges 1. Experience and Expertise lack 2. Heavy Burden on Trial

120 Comments in General Regulations of duty of care only general regulations Regulations of duty of loyalty difficulties of enforcement


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