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Article 180 of the new Company Law stipulates that directors, supervisors and officers (DSOs) bear the obligations of fidelity and diligence to their companies. Drawing on relevant legal provisions and practical cases, the authors of this article explore the specific meanings and judicial standards of these duties, offering suggestions for improving corporate governance and ensuring compliance by DSOs.

Q: What is fiduciary duty and what are the relevant adjudication standards?

A: The Company Law clearly defines the fiduciary duty of DSOs through specific and catch-all provisions.

Article 180 defines fiduciary duty as requiring DSOs to take measures to avoid conflicts of interest with the company and prohibits them from using their positions to seek improper benefits. Article 181 lists five absolutely prohibited actions that violate fiduciary duty and includes a catch-all clause for other breaches of fiduciary duty.

Articles 182 to 184 address three ¡°relatively prohibited¡± conflict-of-interest behaviours: self-dealing and related-party transactions; seizing corporate opportunities; and engaging in competing businesses. To ensure these transactions do not harm the company, they must be approved by the board of directors or shareholders¡¯ meeting as stipulated in the company¡¯s articles of association.

In a related-party transaction dispute involving damage liability handled by the authors, a senior executive directed the company to purchase goods from a related entity he controlled, without board approval.

Years later, the company discovered the executive¡¯s actions had harmed its interests and initiated litigation.

However, since the purchased goods had been almost entirely used up and there is no uniform standard for the raw material composition, it was impossible to determine the price of the goods. A judicial appraisal of the market price was therefore requested.

The appraisal agency used the raw material cost method to determine the market price, revealing that the transaction price was unfairly high and the decision-making process flawed.

Consequently, the court ruled that the executive¡¯s related-party transaction harmed the company¡¯s interests, with an order to pay RMB80 million (USD11.3 million) in damages.

In its ruling, the Shanghai High Court noted that although related-party transactions appear to occur between two parties, they are often decided by just one side, resembling self-dealing and posing significant moral risks. As a result, such transactions must be subject to scrutiny for procedural and outcome fairness.

It can be seen that if the actions of DSOs are procedurally improper, the court is likely to consider various factors to determine what actions have harmed the company¡¯s interests, thereby holding the executive personally liable for damages.

Q: What is diligence duty and what are the relevant adjudication standards?

A: Article 180(2) of the Company Law outlines the duty of diligence for DSOs, stating that, ¡°in performing their duties, they must exercise the reasonable care expected of a manager and act in the company¡¯s best interests¡±. In such cases, where there is no clear conflict with the company¡¯s interests, the law does not list specific actions but instead sets a general standard for judgment.

In the Kangmei Pharmaceutical securities false statement case (2020), the court ruled that although Kangmei Pharmaceutical¡¯s DSOs were not directly in charge of financial management, the prolonged and extensive nature of financial frauds ¨C involving numerous financial accounts and significant amounts ¨C made it implausible that they were unaware of falsifications when signing the financial reports.

As a result, the court found these DSOs had failed to exercise their diligence duties and were significantly at fault, holding them partially liable for investor losses.

In Shanghai Yinxiong Culture Media v Xie Tiantian et al (2022), the court ruled that the company¡¯s DSOs responsible primarily for planning, executing and deciding on major matters were not expected to manage every minor detail personally.

Furthermore, there was no evidence that these DSOs intentionally concealed the company¡¯s external debts, or acted to harm the company¡¯s interests. The losses were due to poor management, not direct wrongdoing by the DSOs, and therefore the court did not support the company¡¯s claim for compensation.

These cases suggest that judges evaluate whether DSOs have breached their duty of diligence from a business judgment perspective. Since China lacks specific regulations on the business judgment rule, judges therefore have considerable discretion.

However, factors such as business innovation, the immediacy of opportunities and investment risks influence entrepreneurial decision making. This means that when judges make retrospective evaluations, many factors affecting decisions may have already changed.

Therefore, the provision that clarifies standards for ¡°exercise the reasonable care expected of a manager and act in the company¡¯s best interests¡± effectively incorporates the essence of the entrepreneurial spirit into the law, aligning with the legislative intent of promoting entrepreneurship in article 1 of the Company Law.

Q: What is your advice on corporate governance and DSO compliance?

A: Companies should their refine articles of association and business guidelines. Companies should tailor articles of association and business guidelines to their specific business fields and operating models. This includes specifying behavioural norms for DSOs and decision-making processes for external agreements, and creating operational guidelines for critical business processes. This ensures that systems are in place to support business operations while providing evidence to assess whether DSOs adhere to their fiduciary duties.

DSOs should ensure compliance in their duties. DSOs, often highly paid professionals, are expected to demonstrate high levels of expertise and loyalty. Given that the results of most business decisions manifest over time, it can be challenging to gather relevant decision-making materials if DSOs have left the company by the time accountability issues later arise.

Therefore, DSOs should ¡°act within their roles¡±, thoroughly understand their job responsibilities, and diligently fulfil review duties. They should also document any differing or reserved opinions, making necessary reports to the board of directors or shareholders¡¯ meeting.

Jiang Lu is a senior partner and Xu Ke is an associate at Ronly & Tenwen Partners.