The author recently searched CNINFO, the China Securities Regulatory Commission’s designated information disclosure platform for listed companies, using the keywords “appointed directors” and “subsidiary directors”. This search yielded 28 and 27 results, respectively, of management systems for listed companies appointing directors, supervisors and officers (DSOs) to their subsidiaries. Additionally, a search using the keyword “subsidiary management system” identified 2,550 results of management systems for subsidiaries of listed companies.
Some of these systems required appointed DSOs to safeguard the interests of the appointing entity. Most stipulated that directors and supervisors must seek the appointing entity’s opinion before voting, and their voting decisions must reflect the appointing entity’s will. In some cases, prior authorisation from the appointing entity was required for voting decisions.
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Certain listed companies have disclosed evaluation systems for subsidiary boards of directors, assessing the operations of boards in wholly owned and controlling subsidiaries. These systems also grant a right to demand rectification by subsidiary boards.
Preliminary observations of these sample systems indicate that listed companies have institutional arrangements requiring subsidiary DSOs to act in accordance with their appointing entity’s will and uphold the appointing entity’s interests. These arrangements are publicly disclosed.
The 2005 revision of the Company Law explicitly clarified that the fiduciary duty of DSOs is owed to the company, not to shareholders. Both the 2013 and 2018 versions of the Company Law reiterated in article 147 that these individuals “owe fiduciary and diligence duties to the company”. Although the new Company Law separates these duties into distinct clauses, it still mandates fiduciary duty to the company.
A simple comparison reveals a clear discrepancy. In the sample systems, the fiduciary duty of DOSs is directed towards the shareholders who appointed them, whereas the Company Law mandates that this duty is owed to the company they serve. This raises the questions: should this discrepancy be addressed under the new Company Law? And how should corporate groups adapt their management of subsidiary DSOs to align with the new Company Law?
Inevitable change
The new Company Law has redefined the duty framework of DSOs. The development of corporate law theory has followed a clear trajectory.
Initially, the contractarian theory of corporation upheld the principle of shareholder primacy, rejecting the consideration of non-shareholder interests in directors’ decision making, to avoid conflicts of loyalty.
However, the team production theory of corporation emphasises that companies involve investments from not only shareholders but from all participants, including employees. This theory assigns directors the role of balancing and co-ordinating the interests of all stakeholders, moving beyond a sole focus on shareholders.
Corporate community theory further extends this concept, asserting that directors have fiduciary duties to all stakeholders of a corporation, a responsibility known as “a multi-fiduciary duty”.
The evolution of corporate law theory is reflected in China’s new Company Law. Article 20 stipulates: “In conducting business activities, companies shall fully consider the interests of stakeholders such as employees and consumers, as well as social public interests like ecological and environmental protection, and shall undertake social responsibilities.” This marks a shift in the statutory duties of directors and senior executives, whose fiduciary duties now extend beyond merely advancing shareholder interests.
Notably, article 191 introduces a system of direct liability for directors and senior executives towards third parties: “If directors or senior executives in performing their duties cause harm to others, the company shall bear compensation liability. If the directors or senior executives act with intent or gross negligence, they shall also bear compensation liability.”
It is evident that the new Company Law reflects the academic theories of the team production theory of corporation and corporate community theory regarding the nature of companies and the fiduciary duties of directors. The fiduciary duty framework for DSOs to balance and co-ordinate the interests of various corporate participants marks a clear departure from the approach of the previous law.
Consequently, the sample systems requiring appointed DSOs to prioritise the interests of their appointers increasingly conflicts with legislative principles in a more comprehensive and intense manner.
The responsibilities of appointing entities have undergone significant changes. Article 192 of the new Company Law stipulates: “If a company’s controlling shareholder or actual controller instructs directors or senior executives to engage in actions that harm the company or shareholders’ interests, they shall bear joint and several liability with the directors or senior executives.” This establishes the liability of shadow director.
Additionally, article 180(3) provides: “If a company’s controlling shareholder or actual controller does not serve as a director, but effectively manages company affairs, the preceding provisions shall apply.” This introduces the de facto director system.
Under shadow director liability, the sample system itself may directly serve as evidence of an appointing entity’s “instructions” to the DSOs of its subsidiary, or as proof of the appointing entity’s actual execution of company affairs. In cases where DSOs breach their fiduciary and diligence duties, the risk of the appointing entity facing joint and several liability increases.
Steps for change
Shareholders often participate in corporate governance by influencing the appointment and removal of directors and supervisors,as well as board decisions. Although directors and supervisors naturally have relationships with their appointing entities, this does not imply that they should act merely as puppets of these entities. Such a scenario would undermine the independence of subsidiaries and cause significant harm to the interests of corporate participants.
Listed companies can implement two steps for change: (1) avoid the existence of these types of management systems; and (2) establish a subsidiary control framework that aligns with the Company Law and modern corporate governance theories. This framework should safeguard the company’s interests and the legitimate rights of stakeholders while protecting shareholders’ lawful rights.
Li Zhiyong is a partner Grandway Law Offices
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