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?
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.
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
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.
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
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
The Structure of Duty of Care
decision making
the board
oversights function
the duty of care
judicial review
B
J
R
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.
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.
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
B.J.R (safe harbor)
• B.J.R： rather than a prescription of standards of
behavior, but a judicial “hands off” attitude——a
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.
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 director’s actions or board
decision.
Justification for the BJR
• 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 managed—stock price falls and hard to raise new capital—vulnerable in
proxy fight or takeover—managers replaced—manager less attractive in the
executive job market.
Reliance Corollary: Delegation of Inquiry and Oversight Functions
• Reliance Corollary: Directors cannot be expected to learn and know about
the full range of the corporation’s 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]
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.
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
Company’s 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
Overcoming B.J. Presumption
• Not in Good Faith
• Irrational Decision—Waste
• Gross Negligence
• Inattention
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 corporation’s
detriment can be held liable under a tort deceit theory.
Conflict of Interests
Director’s liability and action’s validity is dependent on
fairness standards that apply to interest-conflicted
transactions.
Illegality
Breach of duty of loyalty
Irrational Decision—Waste
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
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
board’s failure to become sufficiently informed.
Gross Negligence
•
Trans Union(acquired)
•
Board of Directors
(5 managing directors &
5 outside directors)
•
•
Van Gorkom (CEO)
Roman (CFO)
Prizker (acquirer)
$ 55
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 Gorkom’s role in setting the
merger’s terms:
• -failed to review the merger documents;
• -not inquired into the fairness of the $55 price, and the
value of the company’s significant, but unused,
investment tax credits;
• -acted without inquiry the view of the company’s 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.
Gross Negligence
• Directors asserted they had been entitled to rely on
Gorkom’s 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;
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.
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.
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
president’s 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.
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.
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)
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
director’s dissent or abstention.
• Some courts: challenger to show D’s action/inaction
• 2. Enjoining Flawed Decision
• enjoin/rescind action/unprotected by the BJR
Duty of Loyalty
Self-dealing transaction(自我交易)
Executive compensation (管理者报酬)
Flagrant diversion (转移公司资产)
Usurping corporate opportunity (滥用公司机会)
Parent-subsidiary dealings (母子公司交易)
Selling out (权钱交易)
Promoter’s early dealings with the corporation
(公司发起人与公司的早期交易)
Entrenchment (巩固地位的交易)
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
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
Market transaction:
A
B
$ 102,000
Self-dealing transaction:
A
C
$ 2,000
Purchasing price
Nature of Self-dealing
Question:
Why the purchasing price of the house is only $ 2,000
in a self-dealing transaction?
Answer:
Director C——(Seller) a director of corporation A
——raise the price
——(Buyer) a business man
——lower the price
Conflict
of
Interest
—Reason
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
Nature of Self-dealing
Two broad categories of Self- Interest
Direct Interest
Self- Interest
Indirect Interest
Nature of Self-dealing
Two broad categories of Self- Interest
Direct Interest
—corporation & director
e. g.
①sale & purchase of property
②loan to & from
③furnishing of services
Nature of Self-dealing
Two broad categories of Self- Interest
Indirect Interest
——corporation & person or entity
(in which director has a personal or financial interest)
e. g.
①with director’s close relatives
②with an entity in which the director has a significant financial interest
③between companies with interlocking directors
Judicial Suspicion
of
Self-dealing Transactions
Two basic assumptions
Historical development of fairness test
Judicial Suspicion of Self-dealing Transactions
Two basic assumptions:
Assumption1: human nature
——advance their own interest
rather than the corporation’s interest
——Judicial suspicion of substantive fairness
Assumption2: group dynamics
——identify with their interested directors
even if they don’t have an interest in the transaction
——Judicial suspicion of procedural fairness
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
Statutory “safe harbors”
“Safe harbor tests” in four statutes:
①Delaware GCL § 144
②1984 MBCA § 8.31
③1989 MBCA § 8.61 (Subchapter F)
④ALI Principles of Corporate Governance
Statutory “safe harbors”
Statutory “safe harbors” in four statutes
Three basic principals of “Safe harbor tests”:
①disinterested directors’ approval, or
②disinterested (qualified) shareholders’ approval, or
③fairness
Statutory “safe harbors”
Analysis of similarities and
differences of the four statutes in details
﹡Analysis of similarities of the four statutes in details
★ Burden of prove in the litigation
Directors or shareholders
Burden of prove
Content
Disapproved
Defendant (Interested directors)
Validity
Approved
Plaintiff
Invalidity
Statutory “safe harbors”
★ Two aspects of Substantive Fairness Standard
Objective test: terms of the transaction—principally the price
Corporate value: corporation’s needs and scope of its business
Statutory “safe harbors”
﹡Analysis of differences of the four statutes in details
★ Interested
persons in a self-dealing transaction:
Statutes
Delaware GCL § 144
1984 MBCA § 8.31
1989 MBCA § 8.61 (Subchapter F)
ALI Principles of Corporate
Governance
Interested persons
Directors + Officers
Directors
Statutory “safe harbors”
★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:
Statutes
Delaware GCL § 144
Disclosure requirements
﹡fully disclosed: at the directors’
& shareholders’ approval
1984 MBCA § 8.31
﹡disclosed or not: when judge
1989 MBCA § 8.61 (Subchapter F) determines the fairness
ALI Principles of Corporate
Governance
﹡fully disclosed: in any
circumstances
Statutory “safe harbors”
★Quorum requirements in the directors’ & shareholders’ approval
☆ Quorum requirements in the directors’
Statutes
approval
Quorum requirements
Delaware GCL § 144
Majority (at least one
disinterested director)
1984 MBCA § 8.31
Majority (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
Statutory “safe harbors”
★Judicial review of the directors’ & shareholders’ approval
☆Judicial review of the directors’ approval
statutes
Judicial review of directors’ approval
Delaware GCL § 144
Substance
1984 MBCA § 8.31
1989 MBCA § 8.61 (Subchapter F)
ALI Principles of Corporate Governance
Diluted Substance (Rational: care, best
interest, and good faith)
Diluted Substance (Reasonable)
☆Judicial review of the shareholders’ approval
Statutes
Delaware GCL § 144
Judicial review of shareholders’ approval
Substance
1984 MBCA § 8.31
1989 MBCA § 8.61 (Subchapter F)
ALI Principles of Corporate Governance
Process
Diluted Substance (waste or gift)
Remedies for self-dealing
General Remedy
Exceptions to Rescission
Remedies for self-dealing
General Remedy ——— Rescission（废除）
Rescission:
Returns the parties to their position before the transaction
Exceptions to Rescission ——— Damages（赔偿）
Damages:
The profit made by the director in the self-dealing transaction
Chinese Regulations and Comments
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
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.
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.
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
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;
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;
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 threeyear period has not lapsed since the
revocation of the business license of such
company; and
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.
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.
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.
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.
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.
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;
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;
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;
Questions for Analyses & Discussion
• Question Ⅰ :
categories of self-interest: Signing a contract
or trading with this company
— direct interest
— Disadvantages?
(indirect interest)
Questions for Analyses & Discussion
• Question Ⅱ :
exemption condition: articles of association
or shareholders' meeting
or shareholders' assembly
—The reasons?
— Advantages & Disadvantages?
— Why not the board of directors?
Cases for Discussion
• Case Ⅰ:
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?
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;
Questions for Analyses & Discussion
• Question Ⅰ:
— 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)
Questions for Analyses & Discussion
• Question Ⅱ:
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
Questions for Analyses & Discussion
• Question Ⅲ :
— legal attitude toward
“competition with the corporation” ?
prohibited
or restricted
or allowed
Cases Analysis
• Case Ⅰ:
One senior manger of a company was seeking to
rent an apartment for the company’s 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 ?
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.
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.
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.
Questions for Analyses & Discussion
• Question:
— The relationship between
seizure of income & compensation?
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?
Directors
Officers
Who
(Chinese regulation)
Who
(MBCA & Delaware)
Shareholders’
meeting
Closely held corporation:
Board of directors
shareholders’ negotiation
Public corporation: committee of
outside directors
Executive Compensation
Step2:
What if the director is in control of the
shareholders’ meeting?
——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
Forms of Executive Compensation
﹡Direct forms:
﹡Salaries（薪水）
﹡Bonus（奖金）
﹡Stock plans: Stock grants（股票赠与）
Stock option （股票期权）
Phantom stock （虚拟股票）
Stock appreciation rights （股票增值权）
﹡Pension plans （退休金计划）
﹡Indirect forms:
﹡Fringe benefits: Expense accounts (公务开支的报销单，预算拨款）
Company residents （公司提供的住宅）
Use of corporate jets （使用公司的喷气机）
Judicial Review
Statistics of compensation
judicial review of the compensation
Judicial Review
Statistics of compensation
﹡ Contrasting statistics: (Payments in 1993)
A pharmaceutical corporation in
New Jersey
The USA
CEO
Officers
The president
Congressman
$1,380,000
$600,000$1,060,000
$200,000
$100,000
Remarks: $1,380,000 ≈ $200,000 × 6.9
Judicial Review
Question:
Which one is more difficult?
Managing a corporation
or managing the whole country?
Judicial Review
Judicial Review
﹡ Amazing graphs:
Judicial Review
The most famous critic:
《the Overcompensation of American Executives》
“CEOs are paid hugely in good years
if not hugely,
then wonderfully in bad years.”
Judicial Review
judicial review of the compensation
﹡purpose of compensation plans:
﹡Incentive effect (primary) — maximization of corporation’s value
﹡Tax motivation — avoid double taxation
﹡Squeeze out minority shareholders
Judicial Review
﹡General regulations of compensation:
﹡With disinterested directors’ approval
Business Judgment Review (BJR)
—Grossly uniformed
—Waste
﹡Without disinterested directors’ approval
Substantive Fairness Review
—the executive’s qualification, ability, responsibility, time devoted
—the corporation’s complexity, revenues, earnings, profits
—the possibility of fulfillment of the incentive compensation
—the compensation of similar executives in comparable corporation
Judicial Review
﹡Other necessary regulations of compensation:
《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
Chinese Regulations and Comments
Chinese Regulations and Comments
﹡Regulation Ⅰ:
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
﹡Regulation Ⅱ:
Article 38 (2) The shareholders' meeting shall determine
the matters concerning the director and
supervisors remuneration.
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?
Remedies—Litigation
Ⅰ 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 Plaintiff’s
Expenses
The Nature of Derivative Suit
1.Equity jurisdiction’s 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
corporation’s business, including authorizing
lawsuit in the corporate’s name.
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.
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
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.
•
The Nature of Derivative Suit
4. Reimbursement of Successful Plaintiff’s 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
plaintiff’s litigation expenses, including fees.
 Theory: the plaintiff (and her attorney) produced benefits to the
corporation, and they should be reimbursed for their efforts.
Practice: Plaintiff——Self-appointed Representative, should fairly and
adequately represent the interests of the shareholders
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.
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.
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.
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 people’s court in
accordance with the provisions of the aforesaid
paragraphs.
Ⅰ. 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 plaintiff’s 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.
Ⅰ. 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))
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
Ⅱ. 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.
Ⅱ. The Pre-suit Demand
The Dilemma of board’s 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 board’s
impartiality.
Ⅱ. 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)
Ⅱ. 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.
Board’s objectivity in doubt: Only if the shareholderplaintiff can allege with particularity facts that the
majority of the directors are disinterested and
independent.
Ⅱ. 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.
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
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?
Questions for Analyses & Discussion
• Question Ⅲ :
qualified defendant: directors
senior managers
supervisors
anyone impair the corporation
What is the standing of corporation in this lawsuit?
—Corporation: plaintiff or defendant?
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?
Cases for Discussion
• Case Ⅰ:
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
Remedies—Litigation
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.
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.
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.
• China’s Practice: the right incentive of Judges
1. Experience and Expertise lack
2. Heavy Burden on Trial
Comments in General
• Regulations of duty of care
— only general regulations
• Regulations of duty of loyalty
— difficulties of enforcement