ENFORCEMENT Part Two LIU Zhenzhen May 30, 2014

Page  2 Content  Section 1 General Introduction  Section 2 Outside Director Liablity  Section 3 Shareholder Derivative Suits  Section 4 Conclusion Reference: Outside Director Liability Across Countries (P140) Why Do Shareholder Derivative Suits Remain Rare in Continental Europe? (P150)

Page  3 Section 1 General Introduction  Corporate Law: Encourage investment and protect shareholder  Agency: Shareholder v.s. Director  Enforcemet of Corporate Law: How to motivate the Director to act in the Shareholder's interest? – Director: Legal Liabilty – Shareholder: Shareholder Suits Shareholder Principal Director Agent Agency

Page  4 Section 2 Outside Director Liablity  Director – Inside Director  Directors who are also executives. – Outside Director v.s. Independent Director  Outside Director: Directors who are not excutives.(Non-Executive Director)  Independent Director: Almost the same as Outsider Director, but not allowed to own shares of the company.  Outside Director Liability – Content: Fiduciary Duty – Consequence for Breach of Fiduciary Duty  A lawsuit could oblige outside directors to pay damages or legal fees out of their own pocket. – Aim: To make outside directors work hard and pay attention

Page  5 Empirical Study on Outside Director Liability  Scope of Research CountryFeature U.K.The role of outside director is highly debated. Germany 1. To explore how director liablities in a civil law country 2. To assess the impact of formalizing the role of outside directors through a two-tier board structure Australia Canada Common law jurisdiction France Japan Cicil law jurisdiction South KoreaEmerging market country

Page  6 Empirical Study on Outside Director Liability  Findings – In practice, the legal liability outside director faces rarely lead to personal payments.  Suits could pose the risk of an out-of-pocket payment. – Shareholder Suits: Private Enforcement – Public-minded Litigation: Public Enforcement  However, in most cases, D&O Insuranace is sufficient to cover legal expenses and damages.  Practical Outcome & Analysis –"Functional Convergence"on low (but non-zero) risk –Can the low liability risk motivate outside directors to be vigilant?  The reputational concern  Public-minded litigation – When a governmental agency brings a civil lawsuit.  A tiny risk of criminal prosecution for outside directors  Procedural Consideration: The "American Rule"

Page  7 Theoretical Pros and Cons of Outside Director Liablity Outside Director Liability Substantial Risk PronsMotivate the outside director to be more attentive Cons Directorship: decline Decision-making: counterproductively cautious

Page  8 Section 3 Shareholder Suits: Private Enforcement  Shareholder Class Action – A lawsuit brought for personal claims of all shareholders.  Shareholder Derivative Suit – A lawsuit brought by a shareholder on behalf of a corporation against a third party. – Often, the third party is an insider of the corporation, such as an executive officer or director.

Page  9 The Scarcity of Shareholder Derivative Suits in Continental Europe  The small number of derivative suits in Continental Europe is often seen as a reason why corporate law is considered under-enforced in these jurisdictions.  But the author suggests that – There is a significant degree of enforcement through channels of corporate law, beyond enforcement derived from derivative suits. – If a legal system discourages derivative suits, disgruntled shareholders will take the "Path of Least Resistance" and resort to other enforcement mechanisms. Scarcity of Derivative Suits Under-enforcement of Corporate Law ?

Page  10 Explanations for the Absence of Derivative Suits Four Necessary Criteria 1. Minimum Share Ownership Requirements 2. Costs and the Allocation of Litigation Risk 3. Access to Information 4. Limitations regarding Potential Defendants Anna Karenina Principle

Page  Minimum Share Ownership Requirements  Assumption (Europe) –The incentive for a shareholder with a small amount of shares to bring a legitimate suit is very likely small.  Legitimate motives –The benefits of the lawsuit multiplied by the probability exceed the costs of litigation, including nonmonetary cost.  Percentage Limits (A major hurdle) –Particular percentage: 1%, 5%, 10%… –Pros: A screening mechanism against abusive lawsuits –Cons: Preclude some legitimate suits US Continental Europe No ownership requirements A qulified percentage of the company's share

Page  Costs and the Allocation of Litigation Risk  Law Firm Driven Litigation in the US – Rational Person: Benefit-Cost Analysis – Individual shareholders have little incentive to sue, because  The advantage is small.  The potential cost is substantial.

Page  Costs and the Allocation of Litigation Risk  Legal Rule controlling assessment of attorney's fees arising out of litigation – The "American Rule"  US: Each party pays its own cost regardless of the outcome. – The "English Rule"/The "Loser Pays" Principle  European Countries: The losing party has to reimburse the winning party for litigation costs.  Contingency Fees – US: Contingency fees. – European Countries: Contingency fees are uncommon and illegal.  Requirements to advance court fees – European Countries: High up-front fees

Page  Access to information If meeting the burden of proof is extremely difficult for shareholder plaintiffs, the litigation cost rules may not be enough to encourage suits.

Page  Limitation Regarding Potential Defendants  European Countries – Possible Continental European derivative suits are limited to directors, corporate officers, auditors and the founders of the corporation. – The opportunity to engage with controlling shareholders is therefore limited.

Page  16 Do We Need Derivative Litigation? Inquiry Proceedings Shareholder Derivative Suits Path of Least Resistance Nullification Suit Criminal Investigation

Page  17 Why Do Shareholder Derivative Suits Remain Rare in Continental Europe?  A summary of reasons – The shareholder with a small amount of shares is not qualified to bring a lawsuit due to the percentage limit. – Since the losing party has to reimburse the winning party for litigation costs, shareholders are not willing to taking the risk of having to pay for the defendants' fees. – Meeting the burden of proof is extremely difficult for shareholder plaintiffs – The potential defendants are limited. – Shareholders take the "Path of Least Resistance" and resort to other enforcment mechanisms.

Page  18 Section 4 Conclusion  Outside Director Liability – It's a mechanism of public enforcement when a government agency brings a civil lawsuit against a director. – It's a mechanism of private enforcement when the shareholders bring a suit against a director. – "Functional Convergence" on low (but non-zero) risk is the order of the day for outside directors' personal liability.  Shareholder Derivative Suits – It's a mechanism of private enforcement. – It's arbitrary to conclude that corporate law is inadequately enforced in Continental Europe based on the sparse use of derivative suits.

Page  19 The End. Thanks for Your Attention!